PANC 2014: Fixed Income and Stable Value

That was the consensus of speakers on the
“Fixed Income and Stable Value” panel at the 2014 PLANADVISER National
Conference on Tuesday. “The market sell-off put many stable-value funds under
pressure, pushing them below par to the low 90s,” said David Solomon, vice
president and head of retirement services at Goldman Sachs Asset Management. On
the other hand, “most of the stronger products attracted money despite the
significant declines in other funds, pushing these funds to 101, 102 above
par.”

Immediately following the crisis, a lot of
banks and insurance companies that offered wrappers got out of that business
due to the heightened sense of risk,” Solomon said. For those that remained,
“guidelines got a lot stricter and durations tightened, making the products
more challenging to differentiate or drive alpha. Wrap fees increased
substantially.” The good news, however, is that in the past 12 to 24 months,
“new wrappers have come in, there is more capacity and more liquidity in the market,”
Solomon said.

As the financial crisis erupted and “banks
were tipping, clients asked us—urgently—to review wrappers,” said Robert
Kieckhefer, managing partner of The Kieckhefer Group. Before 2008, the stable
value funds Kieckhefer used typically had between one and three wrappers. Now,
the firm looks for funds with five to eight wrappers. That is one of the key
lessons learned, along with carefully “looking at the funds’ holdings to see
what they are invested in. You might not like all that you find.”

For a full 22 years before 2008, Spectrum
Investment Advisers used a stable value fund from a single “annuity provider.
That worked well with declining interest rates,” said James Marshall, Spectrum
president. Now, Spectrum uses stable value funds “with multiple insurance
wrappers from a dozen different fixed-income providers.”

As to how large of an allocation an adviser
should recommend that an investor assign to stable value, Spectrum manages $1.3
billion in assets, with 13% allocated to stable value. The firm also offers
seven model portfolios, six of which have a small portion invested in stable
value, Marshall said. Given that the current bull market is entering its seventh
year, Spectrum is advising its clients to “move their position up a little bit
to 15%,” he said.

Goldman Sachs recommends that its defined
contribution (DC) plan investors allocate anywhere between 10% and 20% of their
assets in stable value funds, Solomon said, while reminding them and their plan
sponsors that “the biggest risk is demand for liquidity at an opportune time.”

Then there is duration risk, Kieckhefer said.
As a result, the stable value funds that Kieckhefer recommends to clients “have
maturities equivalent to a medium-term bond fund, to sustain a yield. These are
not liquid investments.”

As to what duration of a put provision
Goldman recommends to clients, Solomon said: “We believe in a 12-month put
provision. If you want additional yield, a 24-month put might be more
appropriate. You need to strike the right balance between liquidity and yield.

Kieckhefer typically recommends stable value
funds to clients for safety, rather than yield. “We aren’t crazy about chasing
yield in stable value. We look to fixed income for yield,” he said. That is why
he is comfortable with a 2.5-year put on a stable value fund.

For retirement plans with highly paid participants
that have job security, Kieckhefer might even recommend a stable value fund
with a five- to six-year put. “Many stable value funds are tailored to their
audience, like higher education, which tends to have a stable work force. They
can go after longer durations. Others have huge cycles in their business,” he
said.

To evaluate a stable fund manager, Marshall
said, “there isn’t a [provider like] Morningstar to make it quick and easy.” He
recommends that advisers “first, do a spreadsheet to look at duration. Next,
look at the number of wrappers. Question whether the company has an adequate
support team to do due diligence. Fourth, we recommend puts of 12 months or
less.”

Should the economic environment begin to
change to indicate a pending rise in interest rates, Kieckhefer says he
recommends his clients move out of a long-duration fund into “alternatives,
floating-rate funds and ultra-short bond funds.”

Marshall expects that because of the tremendous
pressure the Federal Reserve is under to strike the right balance on interest
rates, rates will not spike but rise slowly, which he believes will benefit
stable value funds.

Kieckhefer, on the other hand, thinks that a
sharp rise in interest rates is a “spring-loaded trap,” adding that now that
“the economy is getting some traction, we are playing defense.”